Money Manager Predicts An Excellent Year For Bonds

NEW YORK — How far can the hot bond market run? With bond yields dropping fast and most pros predicting another gang-buster stock market in 1986, is it time to dump bonds and shift more into equities?

No, money manager Paul Trevor says. He thinks scrapping bonds would be a dumb thing to do. The risks now are far greater in stocks than in bonds, he tells me, and bonds -- specifically long-term Treasuries -- should have another excellent year.

His forecast is rosy: a total return on your money of close to 25 percent over the next 12 months.

Our bond bull expects a continuing sharp decline in interest rates -- about 110 basis points, or 1.1 percent, by year's end on long-term Treasury bonds (25- to 30-year maturities). That would put rates at about 7 percent. Trevor, in fact, thinks there's a possibility that rates could go even lower.

Given his record -- plus a super bond-market call early last year -- Trevor, 64, is a man whose views are worth considering. He is chairman of Trevor Stewart Burton & Jacobsen, a New York-based money-management concern with assets of about $250 million. The company has outperformed the market over the past 10 years, including 1985, when its average client racked up a gain of 35 percent.

This is my second interview with Trevor. The last time I caught up with him was in January '85. At that time, he predicted a big drop in long-term Treasuries -- specifically 25-year maturity -- of at least a couple of hundred basis points. He told me then that the average investor, for an outlay of about $1,000 for one of those bonds, had a shot at making 30 percent on his money over the next 12 months.

Rates on 25-year bonds, then 11.5 percent, subsequently tumbled, dropping about 200 basis points by the end of '85 and almost another 150 basis points since then. Any investor who heeded Trevor's words at the time and bought one of those bonds would have made a return of 32 percent over 12 months.

Now Trevor is talking up bonds again (principally 25- to 30-year Treasuries) and is putting his clients' money into them in a big way. In fact, just about 80 cents of every investment dollar under his company's control is going into bonds.

His reasoning is simple. Interest rates are driven by inflationary expectations. When inflation is expected to decline, interest rates drop -- leading to higher bond prices. And when inflation is expected to rise, bond prices fall. Trevor is convinced that inflationary expectations will continue to fall as lower oil prices work their way through the economy.

Inflation (as measured by the Consumer Price Index) is running at an annual rate of just under 4 percent, and Trevor predicts a drop in the CPI to about 2 percent by year's end.

Some market pros argue that a growing economy could offset lower oil prices and push inflation higher. But Trevor argues against this view, pointing out that the Federal Reserve Board is still very much committed to its anti-inflation fight.

For the average investor who buys Trevor's scenario and might be interested in a long-term Treasury, one of his favorites is a 30-year bond (maturing in 2016) selling at about $1,100. Its coupon is 9.25 percent, but because the bond is selling at a premium (above the $1,000 par price) its annual yield to maturity is 8.1 percent. Based on his expectations of an eventual 7 percent rate on long-term bonds, Trevor figures a return of close to 22.5 percent over the next 12 months, with about 14 percent of that coming from capital appreciation.

Trevor, it should be noted, is not bearish on the stock market. Overall, he thinks equities have a shot at a 20 percent return in '86. But he thinks the market is much more of a gamble now, especially given its big rise recently.